Factors Affecting Dividend Policy
A number of considerations affect the dividend policy of
company. The major factors are
1. Stability of Earnings. The nature of business has an
important bearing on the dividend policy. Industrial units having stability of
earnings may formulate a more consistent dividend policy than those having an
uneven flow of incomes because they can predict easily their savings and
earnings. Usually, enterprises dealing in necessities suffer less from
oscillating earnings than those dealing in luxuries or fancy goods.
2. Age of corporation. Age of the
corporation counts much in deciding the dividend policy. A newly established
company may require much of its earnings for expansion and plant improvement
and may adopt a rigid dividend policy while, on the other hand, an older
company can formulate a clear cut and more consistent policy regarding
dividend.
3. Liquidity of Funds. Availability of cash and sound
financial position is also an important factor in dividend decisions. A
dividend represents a cash outflow, the greater the funds and the liquidity of
the firm the better the ability to pay dividend. The liquidity of a firm
depends very much on the investment and financial decisions of the firm which
in turn determines the rate of expansion and the manner of financing. If cash
position is weak, stock dividend will be distributed and if cash position is
good, company can distribute the cash dividend.
4. Extent of share Distribution. Nature of ownership also
affects the dividend decisions. A closely held company is likely to get the
assent of the shareholders for the suspension of dividend or for following a
conservative dividend policy. On the other hand, a company having a good number
of shareholders widely distributed and forming low or medium income group,
would face a great difficulty in securing such assent because they will
emphasise to distribute higher dividend.
5. Needs for Additional Capital. Companies retain a part of
their profits for strengthening their financial position. The income may be
conserved for meeting the increased requirements of working capital or of
future expansion. Small companies usually find difficulties in raising finance
for their needs of increased working capital for expansion programmes. They
having no other alternative, use their ploughed back profits. Thus, such
Companies distribute dividend at low rates and retain a big part of profits.
6. Trade Cycles. Business cycles also exercise influence
upon dividend Policy. Dividend policy is adjusted according to the business
oscillations. During the boom, prudent management creates food reserves for
contingencies which follow the inflationary period. Higher rates of dividend
can be used as a tool for marketing the securities in an otherwise depressed
market. The financial solvency can be proved and maintained by the companies in
dull years if the adequate reserves have been built up.
7. Government Policies. The earnings capacity of the
enterprise is widely affected by the change in fiscal, industrial, labour,
control and other government policies. Sometimes government restricts the
distribution of dividend beyond a certain percentage in a particular industry
or in all spheres of business activity as was done in emergency. The dividend
policy has to be modified or formulated accordingly in those enterprises.
8. Taxation Policy. High taxation reduces the earnings of he
companies and consequently the rate of dividend is lowered down. Sometimes
government levies dividend-tax of distribution of dividend beyond a certain
limit. It also affects the capital formation. N India, dividends beyond 10 % of
paid-up capital are subject to dividend tax at 7.5 %.
9. Legal Requirements. In deciding on the dividend, the
directors take the legal requirements too into consideration. In order to
protect the interests of creditors an outsiders, the companies Act 1956
prescribes certain guidelines in respect of the distribution and payment of
dividend. Moreover, a company is required to provide for depreciation on its
fixed and tangible assets before declaring dividend on shares. It proposes that
Dividend should not be distributed out of capita, in any case. Likewise,
contractual obligation should also be fulfilled, for example, payment of
dividend on preference shares in priority over ordinary dividend.
10. Past dividend Rates. While formulating the Dividend
Policy, the directors must keep in mind the dividend paid in past years. The
current rate should be around the average past rat. If it has been abnormally
increased the shares will be subjected to speculation. In a new concern, the
company should consider the dividend policy of the rival organisation.
11. Ability to Borrow. Well established and large firms have
better access to the capital market than the new Companies and may borrow funds
from the external sources if there arises any need. Such Companies may have a
better dividend pay-out ratio. Whereas smaller firms have to depend on their
internal sources and therefore they will have to built up good reserves by
reducing the dividend pay out ratio for meeting any obligation requiring heavy
funds.
12. Policy of Control. Policy of control is another
determining factor is so far as dividends are concerned. If the directors want
to have control on company, they would not like to add new shareholders and
therefore, declare a dividend at low rate. Because by adding new shareholders
they fear dilution of control and diversion of policies and
programmes of the
existing management. So they prefer to meet the needs through retained earing.
If the directors do not bother about the control of affairs they will follow a
liberal dividend policy. Thus control is an influencing factor in framing the
dividend policy.
13. Repayments of Loan. A company having loan indebtedness
are vowed to a high rate of retention earnings, unless one other arrangements
are made for the redemption of debt on maturity. It will naturally lower down
the rate of dividend. Sometimes, the lenders (mostly institutional lenders) put
restrictions on the dividend distribution still such time their loan is
outstanding. Formal loan contracts generally provide a certain standard of liquidity
and solvency to be maintained. Management is bound to hour such restrictions
and to limit the rate of dividend payout.
14. Time for Payment of Dividend. When should the dividend
be paid is another consideration. Payment of dividend means outflow of cash. It
is, therefore, desirable to distribute dividend at a time when is least needed
by the company because there are peak times as well as lean periods of
expenditure. Wise management should plan the payment of dividend in such a
manner that there is no cash outflow at a time when the undertaking is already
in need of urgent finances.
15. Regularity and stability in Dividend Payment. Dividends
should be paid regularly because each investor is interested in the regular
payment of dividend. The management should, inspite of regular payment of
dividend, consider that the rate of dividend should be all the most constant.
For this purpose sometimes companies maintain dividend equalization Fund.
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